In recent years, the term “appraisal gap coverage” has generated a lot of buzz due to rising home values and a competitive, multiple-offer market. But what does it actually mean?
When you buy a home with a mortgage, the bank requires an appraisal — this is an unbiased professional opinion of a home’s value.
Basically, the bank wants to make sure that borrowers are not overpaying because the home serves as collateral for the mortgage.
If the home you’re buying doesn’t appraise at the sales price, you have a few options:
- You can decide to back out of the deal and get your earnest deposit refunded
- You can negotiate with the seller for a price closer to the appraised value
- You can bring additional cash to closing to cover the difference (aka the gap)
Why would a buyer offer to cover the appraisal gap?
In a competitive market where there are bidding wars and multiple offers, offering to cover the appraisal gap or up to a certain amount in the event that the property doesn’t appraise at the sales price can make your offer more competitive and help you stand out.
Still confused? Let me explain…
By covering the appraisal gap, you are agreeing to purchase the home at the agreed-upon price, even if the bank appraisal is lower than expected.
In the event that the appraisal comes in below value, the buyer agrees to pay the difference between the appraised value and the agreed-upon price (or up to a certain amount).
For example, if you make an offer on a home for $300,000 with an appraisal gap coverage clause for up to $20,000, and the appraisal comes back at $280,000, the contract is still in effect, and you would have to bring an additional $20,000 to the closing table or restructure your mortgage.
Make sure you speak with your agent and lender about your options before assuming you can actually make up the difference if the appraisal comes in low — you don’t want to drain your entire savings account or rainy day fund in doing so!
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